Bulletin

Earnings season casts long shadow on rally

Commentary: Outlooks key to financials, techs; Oct. 19 looms

By

DavidCallaway

SAN FRANCISCO (MarketWatch) -- If shares of Google Inc. are running, you can bet it's almost earnings season.

The unexplained rally in shares of the search engine giant
GOOG, +1.20%
up more than 30% in the past seven weeks and some 7% in the past five trading days, can only mean tech-crazy investors are gearing up for another blockbuster quarter.

But behind the traditional pre-earnings rally in Google, which this time has helped propel the Nasdaq Composite Index
$COMPQ
to within shouting distance of 3,000 for the first time in almost seven years, dark forces are gathering.

The sudden rash of earnings warnings this week shows that the twin bugaboos of this summer's credit crisis and the surge in commodity prices have not gone away, and that despite a huge rally in September, the stock market remains vulnerable.

The next three weeks will be the most important of the rest of the year for investors. If the corporate earnings can come out of third-quarter results season better then expected, with few companies issuing warnings or unstable outlooks for the next few months, then the rally could charge ahead through the end of the year and likely into next spring.

But if warnings start to pile up, we could be in for the rough patch many have expected for this time of year. Thomson Financial underscored the growing concern about earnings season on Wednesday when it said that it's possible earnings growth for the S&P 500 Index could turn negative this earnings season for the first time since early 2002. See full story

One key indicator to watch is the financial shares, particularly the banks. The conventional wisdom is that the big banks have already put the worst behind them by writing down some $22 billion in losses for the third quarter and firing hundreds of employees. Merrill Lynch & Co.
MER, +0.57%
Citigroup Inc.
C, -1.08%
Deutsche Bank AG
DB, -3.97%
and UBS AG
UBS, -3.41%
all took big charges, and banks like J.P. Morgan Chase & Co.
JPM, -0.56%
and Bank of America Corp.
BAC, -0.20%
are expected to follow suit.

But if the banks that are still to report couple their charges with poor outlooks and the potential for further write downs, that is where things start to get ugly. Yes, these banks have said they've "marked to market" their credit derivatives and mortgage assets. But the market in those securities could still go down from here.

Of course, next week will be replete with references to the 20th anniversary of the Oct. 19, 1987, stock market crash, and whether it could happen again. My bet is that stocks actually rise that day - next Friday in a sort of bizarre defiance of history. But the rest of the week, and the two weeks after that, are up for grabs.

Investors need to ask themselves this weekend whether we're in a scenario like in August 1998, where the Federal Reserve Board cut rates by 50 basis points and drew a line under the growing Asian currency/Russian debt crisis, ending the turmoil and allowing stocks to resume climbing for two more years before the bottom fell out. Or whether we're closer to 1987, when the bottom fell out that October, but the market then recovered in the last few months of the year and kept rising from there. Or whether it's 1991 and 1992, when the last real-estate crisis claimed many banks in New England and elsewhere, and the country went into recession. Or finally, whether we're just in uncharted territory this time.

As the rally in U.S. tech stocks in the last few weeks, and the rally in markets such as Shanghai, Hong Kong and Mumbai have shown, there is still a ton of cash out there looking for quick profits and the next big thing. But a two-to-three-week dose of sobering news from corporate America could still turn this game around in a hurry.

Only the staunchest bulls believe we'll keep going straight up from here. If there is a turnaround, it will happen before the Great Pumpkin flies.

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